Cheaper to Incorporate?

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New Member

Hi, all ~
I am self-employed, and have been for about 15 years. My tax liability has been growing yearly, and I'm wondering if it would be smarter for me to incorporate, rather than to report my 1099 income on a Schedule C. Does anyone have any advice for this? Thanks so much ~ Laura

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Member

Laura, with tax law being domain- or domicile-specific, the answer to Fergal's question is important. But for the moment I'll speculate that you're in the US, given your references to "1099" and "Schedule C".

Very generally, incorporating a self-employment activity won't buy you anything in the way of income tax mitigation. One particular exception might apply, depending on the circumstances. If your business involves a pretty fair amount of capital (equipment, inventories, real estate, etc.) and/or you have a staff of employees, then you might be able to save a wee bit on self-employment (not income) tax by incorporating and electing S-corp treatment for tax purposes. However, the small savings might well be eaten up by the additional tax prep fee you'd be paying for the S-corp return on top of your personal return. In general, for this exception to have any benefit, your activity's revenues shouldn't be solely attributable to your personal labor and/or services; hence the prerequisites I alluded to. You'd need to lay the details out in front of your tax advisor to explore this one.

At one time in the past, retirement plans and medical insurance plans were two valid reasons for incorporating to capture certain benefits. But over recent years the rules for retirement plans and for medical insurance plans have created parity between the tax treatment for incorporated and unincorporated activities with respect to these two areas, for the most part.

These days, more often than not, people incorporate their businesses for liability protection reasons much more so than for tax reasons.

New Member

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Thank you so much for the excellent help. I was just researching yesterday and came across the S-Corp option. I was giving that serious consideration all day. While my income is comparatively small (just over $30K a year), it's pretty well gobbled up by the double-share of FICA I have to pay. We are on small incomes here and trying to save wherever we can. The business I have is entirely service-oriented; income is based entirely on my personal labor. My per-hour rate varies greatly, though, and I thought a "reasonable" salary could be based upon an average, and I could use that figure to determine earnings.

Your advice is good, though, and I won't be jumping right into that today. If I could afford a tax advisor, I'd go to him Your kind donation of your time is greatly appreciated!

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The business I have is entirely service-oriented; income is based entirely on my personal labor.
~Laura

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This means that going S-Corp wouldn't do much for you in terms of self-employment / FICA tax savings. With 100% of the company's earnings being attributable to your personal labor, IRS would insist that at least a very large percentage of your profits be paid out to you from the corp in the form of salary (which is subject to both employer and employee FICA, unemployment, etc.) rather than as S-corp dividends (which are not).

And it wasn't very long ago that IRS put out the word that they'd be stepping up their scrutiny of S-corps which appeared to be paying out insufficient salaries to their owners. Hence, profitable S-corps with minimal salary deductions are currently on their radar screen.

I like the creativity in your approach to the issue; namely, coming up with an average salary level based on your actual rates, in the hopes that this would allow you to pay out at least some portion of your earnings as S-corp dividends rather than salary. But I can hear a couple of flies buzzing in that ointment...

• A bona fide average, applied to your total hours worked, would just bring you back to a total salary figure that's very close to being 100% of your total earnings, anyway.

• Your total earnings are, by definition, perfectly representative of the fair market value of your services. The pay you receive for each individual hour of work is established in an arm's-length agreement with an unrelated third party. Your $30K+ each year might be composed of individual hourly rates which vary all over the field, but again, in each such hour of work you're getting paid for that hour at a rate that's established via a market agreement. Hence the $30K, as the aggregation of all such hours, represents your market-established fair value for your aggregate services for that year. Thus IRS would likely get kinda cranky at some kind of funny averaging math that somehow sets your salary level substantially below $30K.

While the focus of your question is on tax savings, it's probable that you'd get a much bigger bang for the buck by looking at ways to boost the top line. In many cases, there's only a modest at best bottom-line improvement available by trimming a couple of percentage points here and there from your taxes and other expenses. The real gravy comes from figuring out how to boost revenues by X%.

Not that one shouldn't be diligent in keeping the operation as cost-efficient as possible, it's just that juicing the top line is where the real action is, in terms of increasing your profits.

Best of luck with it, Laura, and do keep bouncing your ideas off the gang 'round here.

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Premium Member

Premium Member

ArcSine's advice was generally on point and very well written but I have to correct one minor statement he made. A C corporation CAN save income taxes, in small amounts, under the right circumstances. A C corporation pays tax on its own income at its own marginal rates which may be lower than your own marginal rates. If you need to retain some of your earnings in the business, for example to increase inventory, you may find that paying corporate income taxes at the lowest marginal rate (15% on the first $50,000 of taxable income) leaves more in your pocket today to reinvest in the business.

Because C corporation income is ultimately subject to double taxation (although you may be able to justify paying out profits as compensation at a later date and avoid a double tax), it is not an easy comparison to make.

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Completely agree, BA, and I appreciate your pointing it out. I superficially skipped past that particular avenue initially, as the vibes I was getting (all revenues attributable solely to owner's personal services; the mention of "trying to save wherever we can") didn't suggest a scenario wherein a big chunk of earnings are being plowed back onto the balance sheet.

But since the frequency with which my assumptions hit the mark would embarrass even a weatherman, I'm glad Laura's now been given a more complete menu of her options.

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